Get Money - Get Out of Debt
Here's a quiz: If you buy a $1,500 couch, put it on a credit card and pay the minimum on your card at 15 percent interest, how long will it take you to pay it off, and what will the couch cost you?
Answer: 10 years and 10 months, and $2,837-you'll pay $1,337 in interest. You've nearly doubled the cost of your couch. More importantly, there's this minor detail called opportunity cost . Economists have all sorts of fancy definitions for it-but it basically means, you paid interest to a credit card company and got nothing back! You not only gave up $1,337 to have the couch immediately, you sacrificed the money you could have made on the $1,337 if you had put it in an interest-bearing account. For instance, if you put the $1,337 away in a tax-sheltered retirement account for 35 years at 9 percent, you'd have $14,666, a sum that can buy you all sorts of fun in your golden years.
So cut off the credit card company, and start using those resources to support your goals. Here's a quick ten-step plan to getting rid of debt:
1. Prioritize your pay-down plan. Make a list of all your creditors, the amount owed, and the annual percentage rate (APR) on each loan. Put them in order from greatest to smallest APR. Direct any extra cash you can generate toward the highest-rate card until it's paid off. Then take the amount you were paying toward that card, and apply it to the next one on the list, working your way down. If you're feeling overwhelmed, pick the card with the smallest balance and get rid of that first. (It may give you the psychological boost you need to keep going.)
2. Pay on time. For all of your cards, pay at least the minimum, on time, to avoid late fees, and establish a record of improving payment history. This sounds simple, but lenders aren't making it easy: Over the past few years, many have reduced the time between when they mail the bill to you and when it's due. Secondly, many companies now sock you with a late fee if your payment arrives just one day tardy-in some cases, if it arrives after 10am on the day it's due! And 85 percent of banks will raise the interest rate on your card if you pay late, according to one study. Some credit card companies will now raise your interest rate if your payment to another credit card company or even your mortgage lender is late. Typically, if you pay on time for six months or several consecutive billing periods, your rate should readjust downward.
3. Negotiate a payment you can afford. If you can't come up with the minimum payments on your cards, call the lenders and negotiate for an amount you can pay. Paying something, even $10 a month, will help you move closer to a clean slate, and may keep the lender from putting you in collection. Ask if they'd be willing to eliminate the late fee and interest for a month.
4. Reduce your interest rates. This can save thousands of dollars over time. The average APR is around 15 percent. If you have several cards that are well above that level, call the credit card companies and ask for a lower rate. In 2002, a group of consumer organizations had volunteers do just that. With a five-minute phone call, 56 percent successfully reduced their rates by an average of one-third-from 16 percent to 10.47 percent. The volunteers simply told the lenders they had received better offers from other companies, and asked the lender for their best offer.
5. Transfer your debt to a lower rate card. If you can't persuade lenders to cut your interest rate, apply to get a new card at a lower APR, and transfer all of your balances to the new card. Just watch out: Some companies offer low interest rates as a teaser, and then assign you a less attractive deal based on your credit score. So verify the terms before you accept the offer. Just as important, watch out for fees on balance transfers. Some lenders treat these transactions as "cash advances" and charge a percentage. For example, if you transfer $5,000 to your new card, a 3 percent fee would set you back $150. So read the credit card offer carefully. You can research credit card offers from banks around the country at www.cardweb.com and www.bankrate.com.
6. Commit to paying 10 percent of the balance every month. Over the years, credit card companies have gradually reduced minimum monthly payments from 5 percent of the balance to 2 percent, one study estimates. This can triple the time it takes to pay off your debt. Commit yourself, as soon as possible, to paying 10 percent of the balance each month.
7. Set specific goals. Motivate yourself by connecting your debt reduction plan to a special milestone: Maybe you want to be debt-free by your 30th birthday, by your 10-year high school reunion, or before your wedding. Check out www.truthaboutcredit.org. It offers a credit calculator that shows how much you need to pay each month to eliminate your balance within a certain time frame. It can also tell you how long it will take to pay off your debt if you continue to pay the same amount each month.
8. Consider credit counseling: If you really can't manage your debt, visit a debt counselor. Be careful: The field is rife with fraud and scams, even by so-called nonprofits. Any firm that asks you for money upfront is breaking the law. Contact one of the following organizations, which can steer you to a local chapter or affiliated agency in your area:
-the National Foundation for Credit Counseling at www.nfcc.org or (800) 388-2227;
-the Association of Independent Consumer Credit Counseling Agencies at www.aiccca.org;
-Consumer Credit Counseling Services at www.cccs.org or (800) 388-CCCS;
-American Consumer Credit Counseling at www.consumercredit.com or (800) 769-3571.
These organizations offer information and structured programs to help you negotiate with creditors. Be sure to ask about fees, the time commitment required and how the program will affect your credit rating (see below). If you can't control your spending, consider joining Debtors Anonymous for support; see www.debtorsanonymous.org.
9. If you've been ripped off, file a complaint: If you believe you are the victim of unfair credit card fees or penalties, contact your state Attorney General's office and the national Office of the Comptroller of the Currency Customer Assistance Group at (800) 613-6743 or www.occ.treas.gov/customer.htm.
10. Eliminate temptation: If your mailbox in stuffed with promotions offering you new lines of credit, call (888) 5-OPTOUT. This will remove your name from prescreening lists at the three major credit bureaus, and greatly reduce your credit card junk mail.
Paying down your debt can greatly improve your credit score. This is a numerical system developed by Fair, Isaac & Co. that makes a huge impression on the people who count, financially speaking. Banks, insurers, landlords, and even potential employers all examine your credit score to decide if you're reliable-and in the case of loans, what they'll charge you. Your "FICO score" ranges from 300 to 850 points. Let's say you applied to get a $150,000 mortgage to buy a home in fall of 2004. If your FICO score was 720 or higher-many lenders would have given you a 30-year mortgage at 5.62 percent-for a monthly payment of $863. If your score was below 560, the exact same loan would have soared to 9.29 percent-or $1,238 a month, a $375 difference. The best way to improve your score is to pay your bills on time and pay down your credit cards. Aim to get your debt down to 50 percent of the maximum credit available on each of your cards-the lower the debt, the better the score. For more tips on improving your credit score, see Money & Happiness, chapter 5, and www.myfico.com "Credit Education."